deferral exceed comp for SE

[Guest tracys]

Self employed deposits $8,500 as "elective deferral" during 2002. CPA gets creative post year end with deductions and reduced net earned income (prior to pension deduction) to $2,500. How is the $6,000 excess in the plan as of 12/31/02 categorized? The 402(g) limit seems to be a dollar cap only - no correlation to compensation. Plus, I'm inclined to think that it cannot be an excess deferral because it's not an elective deferral in the first place. How can one defer income that one does not have? If it's not a deferral, would it just be deemed an employer contribution and then subject to the non-deductible penalty?

[Mike Preston]

It depends on what it really was, doesn't it? If it was a deferral, then it exceeded income and should be returned. If it was a contribution pursuant to a PS portion of the plan, to the extent it exceeded the 415 limit it again needs to be "dealt with". By "dealt with" I mean whatever the document says about contributions in excess of the 415 limit (refund, hold in suspense).

Those 50-75 pages sometimes have some good information in there.

What does yours say?

[Belgarath]

I'd treat as a 415 violation, which can generally be corrected under SCP. Appendix A(.08) of Rev. Proc. 2002-47 states that the correction can be made "using a method similar to that described under 1.415-6(b)(6)(iv)."

[Guest tracys]

If we call it a 415 violation and deal with the excess as prescribed by the plan document, is it still considered a nondeductible contribution as well?

Also, the doc allows elective deferrals to be the first method of correcting a 415 violation. Is the $6,000 an elective deferral (which can be distributed) or an employer contribution (which must be held in suspense)?

Given the increasing popularity of "owner only" plans for SE's, I think we'll being seeing increasing incidents such as this!

[Belgarath]

Under IRC 4972©(3), as long as the contribution is returned before the end of the 404(a)(6) period for the taxable year, no excise tax for a nondeductible contribution is imposed.

Now, there may be a problem determining if this return of excess is allowable as a "mistake of fact." Technically, it probably isn't a mistake of fact. But the accountant could likely come up with some sheets showing botched calculations which would cover this problem. Given the circumstances, I suspect a pretty good argument could be made that this is a "mistake of fact."

Given that this is a 401(k) plan, and that the IRS has standard options for fixing excess deferrals, I doubt this would ever get questioned. They probably wouldn't dig that deep. They haven't on the plan audits I've seen. Certainly, the employer should discuss with tax/legal counsel.

[Guest tracys]

Now we've just had a "owner only" 401(k) client tell us that he contributed $41,000 in 2002 and will show a net earned LOSS on Schedule C. Let's put the "deferral or not a deferral" issue aside on look at the ps portion. If we call it a "participant-level" 415 violation, document calls for it to be put into a suspense account (which is not distributable, of course). At the same time, if we call it an "employer-level" 404 excess, we could return it by the due date of the return and not pay a penalty. Chicken or egg - which came first - the 415 suspense account or the 404 refund of non-deductible? I'm inclined to think that 415 comes first - it goes into suspense and the client pays a non-deductible penalty. Would greatly appreciate any input.